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The biggest challenge of 2018

We enter 2018 with more hope than optimism and judging by how some other countries are performing just a bit of envy as well. The question that is on the mind of most of T&T relates to how we will fare financially.

It is clear that our energy revenues are not going to be the same as it was in the past. We are long past the stage of talking about that reality. The issue going forward is what are our plans to deal with it.

For sure, the government of the day has taken concrete steps to reverse the trend of falling natural gas production, going so far as to engage the Government of Venezuela to address our gas supply issues.

These initiatives are important and necessary as regardless of what happens in other aspects of the economy the energy sector is our life blood both now and in the foreseeable future.

However, on the issue of diversifying the economy away from the energy, we are still very much in the dark. Even before the current administration we have been talking about diversifying the T&T economy for some time but the reality is that up to now we have little to show for it. It is my view that the reason why this is so is down to our failure to address a major prerequisite towards diversifying the economy.

For diversification to take place there must be innovation and entrepreneurship, for that to take place we must awaken the animal spirits and for that to happen there must be the knowledge that capital is available in the right form and at the right price.

We have built an economy that is dependent on capital being allocated through the banking sector to the point where there have been many instances of risks and returns being mismatched resulting in quite telling financial consequences.

The headline-grabbing event of the 2008 global financial crisis was the bail out of US banks following on a systemic banking failure. Yet, between six to nine months after the collapse, some of these same institutions were able to go to the capital markets (stock and bond) to raise the necessary financing to shore up their balance sheet and set themselves up for the future.

A properly developed financial sector needs to have both a well developed banking sector as well as a well developed securities market.

Horses for courses

The term “animal spirits” was first coined by the economist John Maynard Keynes and very briefly the term was used to describe a spontaneous urge to action.

An entrepreneur is bitten with the animal spirit and he is now urged to action.

Does our current system allow him to proceed apace? Is the regulatory environment amenable?

Can he access the necessary capital flows and, more importantly, the right type of capital flows to suit the opportunity?

Even if he is able to do so, does this capital so provided have a ready exit strategy that will allow the provider of capital to exit if and when they so desire?

Asking banks to lend when bank financing is not the appropriate vehicle is not the answer. One can argue that the status quo is costing the country precious time and economic growth.

It is a question of “horses for courses”. Banks typically form very close relationships with its borrowers. It is part of the process of lending. In an environment where there is information asymmetry about a project, for example not wanting to disclose information to a wider audience for competitive reasons, bank financing is the most appropriate vehicle.

However, if you are dealing with standard borrowings of a size that covers the fixed cost of raising capital then it is better from the perspective of economic development and a more robust allocation of capital to tap the securities market for such financing. In fact in a properly functioning financial system capital raised via the securities market tends to be cheaper than bank financing so there is also an intrinsic benefit to the recipients of capital.

Financing innovation

The securities market better facilitates the financing of innovation and innovation leads to increases in productivity which, in turn, translates into economic growth and with that comes a level of economic prosperity.

Two examples make this point clear.

During the Industrial Revolution in the 1800s the UK securities market was able to allocate capital towards innovation much more efficiently than in other countries eventually resulting in the UK leading the Industrial Revolution and then becoming the global power at the turn of the 19th century.

The ability to access capital outside of bank financing by the technology sector in the US from 1980 onwards may have spawned the Internet bubble but it also facilitated the tremendous growth in productivity that has taken place over the past 30 odd years.

I suggest that were the US technology sector completely reliant on bank financing, instead of looking at corporations such as IBM, Apple, Microsoft, Google and Facebook we may be looking to some other country for the technology solutions of today.

In T&T we have identified a number of sectors for development with the aim of diversifying the local economic away from oil and gas. Many of these are in the service sector so the fixed asset based necessary to provide collateral to the bank would be limited. However to date these sectors and so many others are stuck because they are almost totally reliant on Government funding for support.

They are not yet at the stage where they can attract bank financing and do not have access to the necessary levels of equity capital.

In addition even where the equity capital may exist, presumably in the form of venture capital, the absence of a properly developed and functioning securities market means that the exit strategy for the initial providers of equity capital is at best tenuous and so the entire process hardly gets off the ground.

If in 2018 we want to move from talking about economic diversification to actually starting the process of diversification then we have to address urgently the process for financing the innovation that leads to economic diversification.